Wednesday, June 15, 2011

You Should Read Every Word of Every Legal Doc (Especially Funding Docs)

Reid Hoffman was one of my company's (Mixer Labs, acquired by Twitter) investors. One piece of advice he gave me was to read every word of every contract I signed on behalf of Mixer Labs (including the crazy ALL CAPS parts and legalese). This is one of the better pieces of advice I received.

One of the most important set of contracts you will ever sign in the life of your startup are your financing documents. I am surprised by the number of entrepreneurs who depend on their lawyers to read through and decide on key business points of their funding rounds. I will often ask an entrepreneur who is running into an issue about a key issue impacted by their prior funding rounds or employment agreements and their answer will be "I don't know".

Don't Depend on Your Lawyer to Make Decisions for You.
Often, if you ask a lawyer about e.g. a key funding term, they will say "oh yes, the term as written as 'standard'". You should never accept this at face value. Here is a common conversation I would have with my lawyer (who, by the way, was fantastic):Me: "What do you think of term X?"Lawyer: "Term X is standard".Me: "What do you mean by 'standard'?"Lawyer: "Well, 40% of the time it is written this way, and then 30% of the time it is written this worse way, and another 30% of the time it is written this more entrepreneur friendly way"Me: "OK, lets put in the more entrepreneur friendly way".Lawyer: "OK cool"

If I had just let these sorts of things go, our overall situation at the end of our funding rounds would have been much weaker as entrepreneurs.

Plan For the Worst Case Scenario and Clean Up Loose Ends
Given that a lot of entrepreneurs don't read their financing docs, they often don't understand what will happen in different circumstances.

Some example questions on convertible notes: What happens if your convertible note does not convert after 1 year? Does it convert into common on preferred? What happens under acquisition? Can you buy out the note of a badly behaving investor? Etc. etc.

Some example questions for equity rounds: What actions can your investors block under what circumstances (funding rounds, acquisitions, etc.)? If you hire a CEO for your company, does she get one of the common board seats or is a new seat created for the CEO? (this can strongly impact board control)

These are the types of issues that can later come back and really impact your company (e.g. loss of board control) if you do not think about them up front.

You won't think of these issues up front unless you read through all the docs.